The experience of the last eight years shows that many euro-area countries have not yet fully adapted to life in a monetary union with a single monetary policy and currency. This is the conclusion of the Commission Communication on “Strengthening the euro area: key policy priorities”, adopted on the occasion of the EU Economy 2006 Review. More therefore needs to be done to improve growth performance and cement cohesion within the euro area in order to make the benefits of a single currency clearer to its citizens. Structural reforms must be accelerated and public finances more firmly consolidated to create the necessary margin for manoeuvre to weather the next economic downturn. Last but not least, better governance of the euro area is needed, both to ensure closer coordination of national budgets and mutually-enhancing reforms, and to give the euro area a stronger and clearer voice in the world.  Â
In the eight years since its creation, the euro has established itself as a strong and stable currency. Euro-area economies have also responded well to common shocks such as the sharp rise in oil prices or financial market volatility. Inflation has been remarkably low and stable, enabling euro-area governments as well as companies and households to enjoy particularly favourable financing conditions.
However, a continued subdued growth performance and persistent divergences in growth and inflation show that internal adjustment in the euro area is sub-optimal and that some countries have not fully internalised the implications of living in a monetary union.
Learning from the early years of the euro area
Although growth divergences have come down somewhat in recent quarters, they are still persistent and differences in competitiveness and inflation remain (see tables).
These imbalances can be explained by a number of elements:
§Â   First, in a number of countries they reflect the still-ongoing adaptation to falling interest rates and the relaxation of credit constraints on households which started in the run-up to the euro, while in Germany’s case unification had a long-lasting adverse impact on its relative competitiveness.
§Â   Second, some countries have also missed the opportunity afforded by falling interest rates and the consequent savings on the servicing of national debts to consolidate their public finances and enhance adjustment mechanisms to improve their competitiveness now that the exchange rate instrument is no longer available to them.
§Â   Third, in some cases prices and wages have adjusted too slowly to changes in national cyclical conditions and competitiveness trends.
§Â   Fourth, spill-over effects have had an impact. For example, housing booms in several economies have affected both the demand for traded goods and the level of interest rates facing other euro-area members.
§Â   Finally, the varied extent of nominal and real convergence across participating countries partly reflects those countries’ individual policy approaches.
The way ahead to a stronger euro area
The implications of this are clear.
Euro-area members need to accelerate the pace of structural reforms. The recent reform programmes submitted by governments in the framework of the revised Lisbon Strategy for Growth and Jobs show awareness of the reforms needed. But it is delivery – speedy delivery – which really matters.
Governments should be more ambitious in consolidating their public finances, especially now that the area is enjoying a recovery, not only in order to avoid running into difficulties in the next downswing, but also to achieve balanced budgets before the budgetary impact of ageing is fully felt. At the same time, the quality of public spending needs to be reviewed to ensure that growth-enhancing expenditure on R&D, innovation, education and life-long training is increased, not squeezed out.Â
Although significant progress has already been made in integrating financial markets, pushing further ahead with it will increasingly enable the impact of economic shocks on incomes and national credit markets to be smoothed. Similarly, doing more to open up services markets to competition will increase the area’s growth potential and reduce the welfare costs of the adjustment processes. The recent adoption of the Services Directive is good news. The sooner it becomes law within Member States, the sooner Europe will reap the benefits in terms of growth and jobs – just as it did after the liberalisation of previously regulated sectors such as aviation and telecoms.
Economic agents and trade unions, like governments, also need to better grasp the implications of living in an economic and monetary union. For the economy to remain competitive it is important to ensure that wage–price developments reflect productivity gains.Â
The governance of the euro area must also be improved by refining the coordination instruments at both EU and national level in order to reflect the greater interdependence between the euro area’s members and to avoid spillover effects.
Lastly, politicians need to explain the benefits of the euro to citizens or, at the very least, think twice before using it as a scapegoat for an economy’s problems. They should keep in mind the huge benefits that it brings in terms of macroeconomic stability, favourable financing conditions and lower costs for government finances, companies and all consumers alike. It is also essential that policy-makers take full account of the lessons about moving to the euro that have emerged from the current members of the euro area. This will allow countries preparing to join the euro to reap the full benefits of living within a single currency.
Doing all this will make life in the euro area under a common monetary policy smoother and will better equip its members to face the current and prospective challenges of a globalised economy.
The Communication and accompanying EU Economy 2006 Review 2006 are available on the internet at:
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